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Is there anything to be done about this economy? With the Federal Reserve deemed to be running out of monetary firepower and political impasse in Washington making fiscal stimulus largely impossible, few if any policy initiatives remain to lift the U.S. into a satisfactory growth orbit.

The one exception, perhaps, is a Hail Mary strategy that has been discussed and endorsed by some conservatives and liberals alike, from R. Glenn Hubbard, dean of the Columbia Business School and onetime George W. Bush economic advisor, to that stalwart of the left, Nobel Emeritus economist Paul Krugman.

The plan, in its most sensible form, would call for a massive refinancing program that would permit homeowners—ranging from those with lots of equity in their homes to those with deeply underwater loans—to obtain mortgage rates near today's 40-year low of 4% and reduced closing fees. The one big restriction: The program would be open only to homeowners with strong repayment records.

The effects could be far-reaching. Savings in monthly payments would put as much as $80 billion into homeowners' pockets annually, functioning like a substantial, permanent tax cut available as long as people stay in their homes. In other words, people would be inclined to spend the money rather than stash it away, as they did with temporary tax cuts like the Bush rebate checks in 2001 or last year's payroll-tax cuts.

The giant refi would also help to steady home prices by curbing new delinquencies, which lead ineluctably to market-depressing foreclosures. By focusing on responsible buyers and easing their monthly burdens, the program could strengthen credit quality throughout the mortgage system. That, in turn, should hold any costs to taxpayers to a bare minimum.

Millions of homeowners would see big cuts in their monthly mortgage payment under a strong refinancing plan, and that could add $80 billion to the economy annually for years to come.
Lindsay Hebberd/Danita Delimont Photography/Newscom

The program would concentrate on the $5 trillion or so in mortgages held or guaranteed by the federally owned housing finance giants Fannie Mae and Freddie Mac, which make up about 50% of total U.S. mortgage debt. U.S. taxpayers already are on the hook for this debt, so anything the program does to ameliorate future delinquencies would only redound to their benefit.

You might think that with interest rates so low, homeowners wouldn't need much encouragement to refinance. But many are holding back, deterred by the high costs of refinancing—appraisals, credit and income checks, extra fees imposed by Fannie and Freddie on guaranteeing mortgages of less creditworthy homeowners. At the same time, bankers and other lenders have imposed unduly strict underwriting standards on refinances of performing loans in their avidity to keep higher-yielding loans on their balance sheets.

For the economy to enjoy the fruits of a widespread refinancing, the process has to be made streamlined, automatic and less costly for all the $5 trillion in Fannie and Freddie mortgages outstanding that qualify—a universe of, perhaps, $3 trillion in loans.

That's not as tall an order as it might seem. The program would be off and running quickly if the Federal Reserve took steps to lower mortgage rates still further, if Fannie and Freddie eased up on some requirements, and, crucially, if the administration actively publicized the availability of the refinancings and used moral suasion to get banks to participate.

WHILE THE GOVERNMENT has taken some tentative steps in those directions, it hasn't been enough. Only a month into his presidency, Barack Obama unveiled the Home Affordable Refinance Program (HARP). It allowed homeowners with Fannie- and Freddie-backed mortgages to refinance as long as the size of their loan didn't exceed 125% of the property value. But participation by banks and homeowners has been disappointing, for a variety of reasons. As a result, fewer than a million mortgages ended up being refinanced under HARP, and few of them were in the negative-equity position (loans greater than 100% of the home value).

So last month at the administration's behest, Fannie and Freddie's regulator, the Federal Housing Finance Agency, announced a bunch of changes in a program dubbed HARP 2.0. Among other things, the 125% loan-to-value cap was removed, allowing even the most underwater of homeowners to refinance on favorable terms, as long as they're current on their payments. Steps were also taken to lower the hefty fees homeowners pay in a refinancing. Most important, to try to get mortgage lenders on board, HARP 2.0 will eliminate the institutions' potential for losses on any refinanced mortgages as a result of the loans being "put back" to them by Fannie or Freddie because of any underwriting defects. The fear of these "representation and warranty" problems if loans went into default caused many of the lenders to raise, rather than lower, their underwriting standards under the original HARP program, thus discouraging its intent.

Yet HARP 2.0, like its predecessor, will probably fall short of providing much stimulus, according to Mark Zandi of Moody's Analytics. For one thing, it targets only homeowners with less-safe loan-to-value ratios of 80% or more, extending few of the cost savings initiatives and put-back protections to safer mortgages, those below the 80% threshold.

Moreover, lenders may not play ball by permitting borrowers to take full advantage of the lower mortgage rates available, preferring to profit from the old, higher-yielding loans. The industry has dramatically consolidated since the 2008-2009 credit crisis, with national powerhouses like Bank of America, JPMorgan Chase, Citigroup and Wells Fargo having unprecedented market power, says Zandi. Finally, the infrastructure of most mortgage lenders remains grossly inadequate to handle any onslaught of refinancing, as illustrated by the recent robo-signing scandal involving foreclosure practices.

Consequently, Zandi expects HARP 2.0 to generate only about 1.6 million refinancings out of what he estimates are about 14 million Fannie- and Freddie-backed mortgages eligible for refinancing over the remaining two years of the program's life. The savings in monthly payments will also be paltry—just $4.5 billion in 2012 and $2 billion in 2013. "It's hardly a silver bullet when compared to the payroll-tax reduction that put some $120 billion into consumers' pockets last year," Zandi points out.

SOME OBSERVERS THINK, probably correctly, that economic exigencies will argue for a far more ambitious refinancing program by next year. Joseph Gagnon, who formerly held a senior position at the Federal Reserve in Washington and is now a senior fellow at the Peterson Institute of International Economics, floated such a plan several months back, provocatively entitled "The Last Bullet."

According to Gagnon, the Fed should unleash a major campaign of quantitative easing, concentrating its firepower on Fannie and Freddie mortgage-backed securities, known as agency securities, to push mortgage rates from the current 4% to as low as 3%. Many market participants already expect a bout of quantitative easing early next year, with the Fed buying about $550 billion agency mortgage-backeds, but Gagnon thinks the central bank ought to amp up the purchases to $2 trillion to ensure the desired effect.

The decline in mortgage rates he is pushing for, all other things being equal, would result, by his reckoning, in the refinancing of around half of the agency-backed mortgages outstanding, totaling some $2.5 trillion in principal amount. This would yield about $60 billion to $80 billion in savings a year for homeowners, potentially lifting the growth of gross domestic product by about half a percentage point. That is a considerable amount at a time of paltry 2% GDP growth, and it would be the gift that keeps giving for many years to come.

In Gagnon's estimation, HARP 2.0 just doesn't cut it. He finds it silly, for example, that mortgage holders with loans smaller than 80% of the property value won't qualify for many of the relaxed credit standards accorded more risky loans. "I would refinance everybody, waiving all requirements and surcharges on any of the agency loans as long as the homeowner has had an unblemished repayment record for the past two years," he asserts. "I'd also insist that Fannie and Freddie send letters to all borrowers who qualify, rather than merely relying on a press release from their regulator to get the word out," which has been the approach so far.

R. Glenn Hubbard and his colleague at the Columbia Business School Chris Mayer have been pushing for a major-league mortgage-refinancing program for some time in academic papers and op-ed pieces in the likes of The Wall Street Journal and New York Times. Hubbard has impeccable Republican credentials, having served as head of the Council of Economic Advisers under George W. Bush. Interestingly, a variant of their plan was proposed by Senate Republican leader Mitch McConnell in early 2009 as a cost-effective alternative to the Obama stimulus bill, but was dropped from the final bill.

Hubbard and Mayer want to extend the opportunity to refinance beyond Fannie and Freddie to all federally guaranteed mortgages including those backed by Ginnie Mae, the Department of Veterans Affairs and the Federal Housing Administration—resulting in some 20-million mortgage refis, versus 15 million under Gagnon's plan. The purchasing power that such an effort might unleash could be as high as $100 billion a year, Mayer tells Barron's.

An official at the Federal Housing Finance Agency scoffs at all this. For one thing, the estimates that critics like Hubbard and Mayer make of the number of mortgages that might qualify for such a large program are, in her words, far-fetched. Nor do Fannie and Freddie have the manpower or automated systems to handle anywhere near the number of refinancings that a large program would entail, she says. Finally, the two agencies are limited in the pressure they can exert on lenders to lower rates for homeowners.

Conceivably, the program would raise Fannie and Freddie's credit risk, since they would be losing the ability to put back shoddy loans. But remember, the program would be open only to homeowners with strong repayment records, and with lower mortgages rates, those records should remain strong for years to come. From seasoning of these mortgages, most of the fraudsters and deadbeats have largely eliminated from the pools.

OF COURSE, there would be other costs. Investors in mortgage-backed securities, into which the overwhelming bulk of Freddie and Fannie mortgages are bundled, would lose some income as higher-yield mortgages give way to lower-rate paper. Prices of agency mortgage-backeds would drop some from the flood of early repayments. Jeffrey Gundlach, the head of DoubleLine Capital and legendary bond investor, calculates for Barron's that a large refinancing program could result in about $300 billion in mortgage-backed securities price declines on a total of $5 trillion in agency paper outstanding, representing a decline of about 6%.

Yet those losses would be spread among a disparate roster of holders, including Fannie and Freddie (they own $1.2 trillion in agency paper in their proprietary trading investment portfolios), the Federal Reserve (currently $840 billion in agency mortgage securities on its balance sheet), and major bond managers like Pimco, BlackRock, Fidelity and the government of China.

Those investors and others can't complain too much. Most are sitting on huge capital gains by virtue of the Federal Reserve-engineered drop in long-term interest rates since the dark days of 2008.

Mortgage-backed securities prices also have benefited mightily from the late 2008 federal seizure of Fannie and Freddie, which gave the agency's obligations the explicit guarantee of the federal government. Until then, the guarantee had been only implicit.

Plenty of hurdles remain for carrying out a massive refinance of housing. Banks and other mortgage originators will probably have to be bullied some to scale up their efforts and offer truly attractive mortgage rates. The bureaucrats at Fannie, Freddie and their regulator are never anxious to undertake the kind of mammoth effort that a major program would entail, even if it is indubitably in the public interest. Lethargy is the path of least resistance for large organizations.

Nevertheless it's high time to do something. And, perhaps, financial engineering by the government can repair the extreme damage that financial engineering by Wall Street wrought on the housing market and U.S. economy.